Digitisation: transforming the role of central banks

With the rapid pace of technological change in global financial markets, central banks are increasingly recognising that many legacy tools, methods and manual processes are inadequate, writes Sachin Somani

Advancements in technology are having a significant impact on the way global financial markets operate, with banks of all sizes investing in automation and innovation to allow them to take advantage of new opportunities. Similarly, digitisation is becoming increasingly important in the way central banks operate and interact with market participants.

One of the main drivers of this is the availability of vast amounts of data, on which central banks rely to formulate policy and understand the machinations of global financial markets. As technology evolves, many central banks recognise automation, and data can create new opportunities for more efficient functioning of financial infrastructures.

The Covid-19 pandemic has further increased demand for this data to be captured and consumed in a timely manner, as central banks rapidly respond to changing market conditions. This means technology that delivers relevant data in an easy-to-use and actionable format is of great value.

Central banks also have a growing role to play in evaluating technology innovation and promoting the adoption of new technology while ensuring financial stability and the efficient operation of the world’s markets.

This article considers the interconnectedness of the trade lifecycle within a central bank and how digitisation can be applied at each stage to ensure the smooth and efficient operation of the financial markets – from primary and secondary markets, to post-trade, market insight, benchmarks, surveillance, and environmental, social and governance (ESG).

Digitisation in primary markets

Central banks play a critical role in managing liquidity and price stability. In developed, emerging and frontier markets, they conduct auctions and open market operations to manage currency flows, primary market issuance and the facilitation of international trade. To do this in an effective manner, central banks need to operate transparent and compliant processes across multiple asset classes.

Advances in technology mean auctions and open market operations can be automated using technology platforms, which connect central banks with primary dealers and digitise many aspects of the process. This digital solution maximises efficiency and timeliness in conducting auctions and open market operations, delivering increased value to central banks and their economies.

Digitisation in secondary markets

In the secondary markets, access to liquidity is key. Trading activity can be limited by high transaction costs, slow order execution and operational risk, whereas leveraging new technology to improve transparency and access can lead to the availability of deeper liquidity and increased trading volumes.

The impact made by automation can be particularly significant in frontier and emerging markets. For example, deploying efficient trading systems in these markets enhances access, transparency and accuracy, while adding credibility to the countries in question in terms of firms wanting to trade in their secondary markets.

A trading platform can offer banks and central banks access to deeper liquidity, efficient execution and automated trade reporting tools. Market participants benefit from the digitisation of trading workflows, including the ability to trade with their relationship banks on a multibank platform, which provides a range of functionality from accessing liquidity to straight-through processing.

These trading platforms support transparent trade execution in compliance with local regulations and adherence to codes of conduct such as the FX global code. In addition, a central limit order book enables further improvement of access to liquidity in a way that is transparent, efficient and cost-effective.

By using electronic trading platforms, the resultant data can be instantly accessible and free from manual errors. Not only can parties to transactions rely on technology for secure, uninterrupted communication, but central banks can use this data to enhance the monitoring of secondary market activity.

The digitisation of many secondary markets has resulted in the availability of trading solutions that support a range of instruments including fixed income, repos, overnight index swaps, interest rate swaps and sharia, providing benefits for all market participants from central bankers and regulators to the sell side, the buy side and corporates.

Automating post-trade processing   

Post-trade operations are a vital part of any trade lifecycle within a central bank, but post-trade technology in banks globally has suffered from underinvestment in recent years.

Technology spend has tended to focus on front-office activities and the drive for low-latency connectivity, algorithmic trading and automated trader workflows. As a result, too many banks have been operating ageing and largely inflexible post-trade infrastructures for many years.

Banks in emerging markets in particular have low levels of automation in middle- and back-office functions, and many still rely heavily on manual intervention, giving rise to increased costs and a high level of operational risk from keying errors. Seeking to bring efficiency and cost-effectiveness to the entire trade lifecycle, banks are increasingly focusing on post-trade technology – particularly risk management and the optimisation of collateral. Such technology allows market participants to satisfy regulatory scrutiny by demonstrating transparency throughout the trade lifecycle.

Enhancing market insight

A clear view of the trading practices of financial institutions is a vital part of ensuring regulatory compliance. Similarly, there is a need to monitor markets to ensure price stability. Central banks need access to relevant information in a timely manner to intervene quickly.

In developed economies in Europe, for example, trade repositories are an important part of the financial markets ecosystem but are often uneconomical for some emerging and frontier markets. The digitisation of data, however,  helps central banks in these markets address many of their compliance requirements by enabling access to fast, independent and comprehensive sources of data.

Replacing the traditional manual methods of storing and analysing data, automated solutions can capture and normalise transactional and reference data, and combine it with unstructured data such as news, to allow advanced analytics to be applied against all the data.

Access to an accurate, trusted and objective news source is vital, whether for monitoring global affairs, research and analysis, data modelling or market risk surveillance. Similarly, economic data that focuses on events affecting global financial markets along with pricing and market data is an important resource for central banks. Thanks to advanced technology, such data is now readily available for distribution and analysis.     

Transition to trade-based benchmarks

Central banks can use key foreign exchange and interest rate benchmarks and indexes to provide them with analysis and data tools to enable a better understanding of the way financial markets function in their individual countries.

With digitisation continually improving access to transaction data, the trend is towards replacing survey-based with trade-based benchmarks, which are more robust and better reflect market conditions. Trade-based benchmarks align with the International Organization of Securities Commissions’ (Iosco’s) Principles for financial benchmarks, the internationally accepted standard.

Automating market surveillance

Surveillance is a major theme for central banks globally as they look to safeguard their financial markets. Numerous data vendors and technology companies specialise in market surveillance, but a central bank may consider partnering with a single provider that can supply both over-the-counter and exchange data, and the technology to monitor, detect and report anomalous behaviour in the market.

In times of crisis, this means a central bank does not need to manage multiple vendors, saving valuable time. Digitisation eliminates previous resource-heavy methods of collecting and monitoring market data, creating efficiencies and enabling central banks to approach supervisory and market oversight practices in a highly efficient manner.     

Enabling ESG

Central banks are increasingly focusing on the opportunities of responsible investment for market stability and effective management of government reserves. Incorporating ESG considerations into policy decisions can play an important part in the protection of a country’s resources and economy.

A reliable source of ESG data can help central banks assess the opportunities and risks posed by companies’ performance in critical areas such as climate change. To carry out effective research, it is important such data is rigorously quality controlled, standardised and verified.   

Digitisation in Indonesia

Bank Indonesia has made a commitment to strengthening the country’s financial markets by adopting digitisation and implementing automated solutions throughout the trade lifecycle. Having successfully automated its primary market auctions, Bank Indonesia has introduced electronic broking systems, such as Refinitiv Matching, to complement conversational dealing and increase liquidity, efficiency and market transparency in line with its blueprint for developing and deepening financial markets.

Using Refinitiv Market Tracker, Bank Indonesia obtains in-depth trading data, which it uses to view the markets under its jurisdiction and calculate its trade-based benchmarks. The central bank also leverages on market surveillance solutions to detect any breach in market regulations or disorderly market behaviour.

No one size fits all

With the rapid pace of technological change in global financial markets, central banks are increasingly recognising that many legacy tools, methods and manual processes are inadequate and can potentially create inefficiencies in delivering their services.

Central banks are increasingly understanding, evaluating, prescribing and adopting new technology solutions to perform a supervisory role within the global banking system. To continue the digitisation of financial markets, some central banks have taken a leadership role in setting standards and frameworks and to advise market participants in their countries on such factors as risk management, data security, regulation and codes of conduct. Central banks yet to take this leadership role should consider partnering with a technology firm that understands how central banks operate at the heart of the financial ecosystem, and is able to demonstrate an understanding of how digitisation can improve efficiency and transparency in all the elements of the trade lifecycle.

The pace of digital evolution differs across countries and regions, where every economy – and therefore every central bank – is at a different stage. For this reason, different technologies will support different processes. It is incumbent upon each central bank to look at the technology and data vendors available to help them implement polices by which they can ensure the efficient operation of the financial markets.     

Enhanced technology solutions

Developing advanced solutions for all activities in the trade lifecycle, Refinitiv is an established provider of technology to central banks worldwide, helping them improve operational efficiencies, increase transparency and monitor markets. Now part of the London Stock Exchange (LSEG) Group, Refinitiv can leverage LSEG companies’ foundations on data collection, granularity and transparency.

These enhanced solutions can help central banks make markets more robust through improved reporting and market surveillance tools, and enable financial institutions to access larger pools of liquidity. LSEG and Refinitiv provide secure analytics and tools that are relied on daily by banks and central banks, execution venues for liquidity access and price discovery and clearing houses, which help manage risk and capital.

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